House Executive Pay Legislation Puts Pay Czar's Boot in the Door

Understandably concerned over taxpayer-subsidized bonuses, the
Obama Administration appointed a "pay czar" to oversee compensation
at firms receiving substantial government backing, such as GM and
AIG. Regrettably, the Administration did not stop with
government-aided companies but proposed a sweeping plan regulating
private-sector pay.[1]

On July 28, the House Financial Services Committee approved H.R.
3269, the Corporate and Financial Institution Compensation Fairness
Act of 2009, introduced by Chairman Barney Frank (D-MA), to
regulate pay practices in the entire financial sector. Further, the
Obama-Frank plan moves toward comprehensive government regulation
of private-sector pay, extending to rank-and-file employees. The
plan represents the czar's boot in the door opening every
American's pay to government regulation.

The Obama-Frank plan is misguided not because the private sector
is perfect but because government dictates complicate and distort
private-sector pay without addressing pay inequities. In fact,
existing tax policy encourages the big bonuses that have spurred
public outrage. Instead of regulating more, Congress should revise
tax rules to make pay decisions tax neutral.

The Obama-Frank Plan: Three Bad
Ideas

Say on Pay, but Nothing Else. The Obama-Frank plan
requires annual, non-binding shareholder votes on senior executive
pay at most publicly held firms. There is nothing inherently wrong
with a shareholder role in compensation decisions, but
government-mandated pay disclosures, votes, and procedural
requirements distort management-shareholder relations by focusing
excessive attention on compensation. As a result, other important
factors affecting corporate performance will suffer in comparison
as management--and shareholders--have less time to give them the
attention they deserve.

Bureaucratic Compensation Committees. The House bill
requires that covered companies have independent board compensation
committees with authority to hire outside compensation
consultants.[2] The government "hint" and fear of liability
mean nearly every compensation committee will hire
government-approved experts to set corporate pay.

Total independence in setting pay is at odds with the idea
touted by those backing new pay rules that compensation should be
aligned with long-term corporate interests. Prohibiting a CEO from
participating in compensation decisions for other senior executives
sacrifices a key management tool. While corporate executives cannot
be allowed to simply set their own pay, excluding them makes
compensation decisions a bureaucratic exercise by outside
consultants. This is a sure recipe for a mismatch between corporate
goals and corporate pay.

Moreover, details such as price, vesting, and exercise rights
make significant differences in incentives created by options,
which are only one of many forms of incentive compensation. Even if
regulators had accurate ideas about how compensation creates risk,
the detail required to implement those insights would require
bureaucratic micromanagement of private-sector pay.

Not Just Fat Cats

While "say on pay" votes apply to top executives, other
provisions of the Obama-Frank plan affect rank-and-file employees.
Financial firms must report incentive compensation--including such
routine items as commissions and performance bonuses--for every
employee. Financial regulators could prohibit "unreasonable
incentives" for any employees. If regulators think commissions are
too high or bonuses are poorly calibrated, they can order
revisions.

Rank-and-file employees outside the financial industry would not
be regulated directly--at least not yet. But rules on senior
executives influence how corporations pay other employees. Security
and Exchange Commission (SEC) rules require corporations to explain
the objectives, design, and elements of their overall compensation
program in disclosing the pay of senior executives. Thus, new rules
imposed on corporate compensation committees interact directly with
overall compensation plans. Limits on top executives roll down to
the rank-and-file.

Existing Tax Rules Distort Pay
Practices

Corporate critics claim some compensation incentives (such as
stock options) encourage managers to take undue risks affecting the
entire company in order to meet personal performance goals.
However, the emphasis on incentive compensation springs
significantly from a 1993 law intended to limit executive
compensation.

Section 162(m) of the tax code limits deductible salaries to $1
million but allows unlimited deductions for performance-based
compensation. The result, as an SEC official noted, is that options
exploded: "[T]he tax law tilted compensation practices away from
salary ... in favor of performance-based compensation to which the
cap didn't apply, such as stock options."[5]

Moreover, the 1993 law produced the opposite of its intended
results. Executive compensation increased, and the disparity
between executive and rank-and-file salaries grew.[6]

Rather than removing perverse government incentives, the
Obama-Frank plan attempts to solve problems caused significantly by
existing regulation with more regulation. New regulations are
unlikely to have a better result; most likely they will have
spectacular failures of their own. Policymakers should cover their
ears and avoid any tempting siren calls for even more government
regulation of private-sector pay.

Keeping the Czar's Boot out of the
Door

Americans are understandably disfturbed when taxpayer-supported
companies pay outsized bonuses. But government regulation of
private-sector pay is no solution. Existing tax law encourages
excessive focus on executive bonuses. Additional government
intervention will imbalance corporate governance and further
distort pay practices.

Rather than dictating private-sector pay, policymakers should
re-examine the pernicious effects of existing tax incentives on
executive pay. Rather than increasing involvement in private-sector
decisions, policymakers should make government policies neutral as
to pay structures and allow private-sector owners and managers to
design differing pay systems for different companies and
objectives.

David M. Mason is a Senior Visiting
Fellow in the Thomas A. Roe Institute for Economic Policy Studies
at The Heritage Foundation.

[2]Most
corporate boards have "inside" directors who are senior executive
employees of the corporation as well as "outside" non-employee
directors. H.R. 3269 requires that a committee composed exclusively
of outside directors make compensation decisions.

[3]Incentive payments are limited to long-term
restricted stock. See U.S. Department of the Treasury, "Treasury
Announces New Restrictions on Executive Compensation," February 4,
2009, at http://treasury.gov/
press/releases/tg15.htm (July 30, 2009).

Share

The Obama Administration appointed a "pay czar" to overseecompensation at firms receiving substantial government backing.Regrettably, the Administration did not stop with government-aidedcompanies but proposed regulating private-sector pay.

Rep. Peter Roskam (R-IL) says it's "a great way to start the day for any conservative who wants to get America back on track."

Sign up to start your free subscription today!

Sorry! Your form had errors:

About The Heritage Foundation

The Heritage Foundation is the nation’s most broadly supported public policy research institute, with hundreds of thousands of individual, foundation and corporate donors. Heritage, founded in February 1973, has a staff of 275 and an annual expense budget of $82.4 million.

Our mission is to formulate and promote conservative public policies based on the principles of free enterprise, limited government, individual freedom, traditional American values, and a strong national defense. Read More